Reference no: EM132851149

Question McClain Plastics has been an audit client of Belcor, Rich, Smith & Barnes, CPA (BRS & B), for several years. McClain Plastics was started by Evers McClain, who owned 51% of the company. The balance is owned by around 20 shareholders who are investors without operational responsibility. McClain plastic makes plastic products its main ingredient. Some are made to order, but most products are made to stock. An example of a product that McClain manufactures is a plastic chair cushion used in carpeted offices. Another are plastic bushings that are used with a specific fastening system. McClain has grown from a small, two-product company, when they first got engaged to BRS & B, to a successful diversified company. By the time BRS & B's Randall Sessions became audit manager, annual sales had grown to $ 200 million and profits to $ 10.9 million. Historically, the company has had no unusual audit problems, and BRS & B has published an unqualified opinion every year. The BRS & B audit approach that has always been used in McClain Plastics audits is a "sub-approach to auditing stantive. responsible for obtaining under the position of internal control as part of the risk assessment procedure, but control risk is rated at the maximum (100%). Extensive analytical procedures are performed in the income statement, and unusual fluctuations are investigated. Detailed audit procedures of balance sheet accounts are emphasized. The theory is that if the balance sheet accounts are correct at the end of the year and have been audited at the beginning of the year, then it is maintained that the income and income statement must be correct.

Part I

In evaluating the audit approach for McClain for the current year audit, Session believes that the substantive approach is really only appropriate for small, nonpublic audits of firms. In his assessment, McClain Plastics, with $ 200 million in sales and 146 employees, has reached the uneconomical, and perhaps unwise, measure of concentrating semuates on the balance sheet. In addition, although McClain is not a public company, Session acknowledges that similar public companies are required by Article 404 of the Sarbanes - Oxley Act and related PCAOB standards to have an integrated audit of financial reports and internal control over financial reporting. Therefore, he designed an audit program that emphasized the identification of internal controls across all major transaction cycles and included testing of controls. The intended economic benefit of this "reduced control risk" approach is that the time spent on testing controls will be more than offset by testing that minus the details of the balance sheet accounts. In inventory planning testing, Session uses the audit risk model included in the standard audit to determine the number of inventory items that BRS & B will test at the end of the year. Because of the number of different products, features, sizes and colors, McClain's inventory consists of 2,450 different items. This is maintained on a perpetual inventory management - a system that uses a relational database. In using the audit risk model for inventory, Session believes that the audit risk is 5% acceptable. He values ??the inherent risk as high (100%) because inventory, by virtue of its own nature, is subject to many types of misstatement. Based on his understanding of the relevant transaction cycle, Session believes that internal control is good. He therefore assesses control risk as low as possible (50%) before performing control testing. Sessions were also planned to use analytical procedures for inventory testing. This planned test includes comparing gross profit margins per month and reviewing slow moving items. Session believes that this test will provide a guarantee of 40%. A substantial detail test will include testing of inventory quantities, costs, and net realizable value at the interim date of 2 months prior to the end of the year. The deadline test will be conducted at the end of the year. Inquiry and analytical procedures will be relied on for assurance about events between the interim audit date and the end of the fiscal year.

a. Decide which of the following is most likely to be done under both control risk less the substantive approach and the approach:

(1) Assess inherent risk.

(2) Obtain an understanding of internal control.

(3) Perform control testing.

(4) Perform analytical procedures.

(5) Assess the risk of planned detection.

b. What advantages does the control risk reduction approach Session plan to use over the substantive approaches previously used in the McClain Plastics audit?

c. What advantages do the substantive approach have over the reduced control risk approach?